By Ann Zimmerman
Sales and profit growth have started to slump at the deep-discount retailers called dollar stores, after a robust performance during the recession, a sign that even fairly cheap toys and other small indulgences now are a stretch for some consumers.
In the past several weeks, Dollar General Corp., Family Dollar Stores Inc. and Dollar Tree Inc., the country's three largest chains that sell sharply discounted food, household staples and other items in modest-size stores, all have missed their quarterly earnings targets.
All three retailers cited transportation costs due to rising diesel-fuel prices as a major reason for their earnings shortfalls. But the chains also said their price-sensitive customers, pummeled by high unemployment, stagnant wages and soaring gasoline prices, are buying more food and other basics like cleaning products, which have relatively low profit margins, and fewer higher-margin discretionary products, such as apparel and home decorative items.
Shoppers have become less likely to splurge, for example, even on a $5 die-cast Transformer toy or 2-for-1 children's bathing suits at $7.
"This is a sector that was in nirvana during the recession, as customers traded down," said Adrianne Shapira, a retail analyst at Goldman Sachs. "But now their shoppers have a bunker mentality. With all this mounting inflation crowding out discretionary purchases, it's painful."
The chains, meanwhile, are facing rising food prices that they have been reluctant to pass on to their struggling core customers, who typically have family income of less than $40,000.
The cost and margins pressures are beginning to echo similar ones at Target Inc. and Wal-Mart Stores Inc., which occupy a higher rung of the market. While retailers last week reported better-than-expected sales in June, raising hopes that consumers were ready to spend again, Friday's dismal jobs report, which showed unemployment climbing to 9.2%, renewed concerns that shoppers would remain cautious.
All three dollar-store chains continue to post same-store sales—or sales at stores open at least a year—that their bigger discount rivals would envy, with Dollar General, Family Dollar and Dollar Tree reporting gains in the latest quarter of 5.4%, 4.7% and 7%, respectively, from a year earlier. Still, Dollar General and Family Dollar, which sell a high proportion of food and household basics, have seen their sales increases drop from the torrid pace of just a few years ago.
Dollar General posted earnings for the fiscal first quarter ended April 29 that missed Wall Street's expectations by two cents a share. But the biggest surprise was that its gross margin rate shrank by 0.63 percentage point, as the company marked down leftover winter clothing and home furnishings. It also refrained from passing along its higher commodity costs on such products as coffee, whose wholesale price has risen four times since December.
Two weeks ago, Family Dollar, facing many of the same pressures as Dollar General, missed analysts' earnings expectations by four cents a share for the quarter ended May 28. Its same-store sales gains also were lower than analysts expected, as was its gross margin rate, which fell by about 0.36 percentage point.
Family Dollar blamed the margin squeeze mainly on shoppers's inability to afford more discretionary products.
The evidence could be seen recently in the aisles and shopping carts at a Family Dollar store in North Dallas. A large circular rack of clothing marked "clearance" was filled with unsold winter clothes, such as fleece shirts and baby warm-up suits, for $5. But even summer clothing, such as $8 white Capri pants and $10 shorts, were being offered on a "buy one get 50% off on a second" basis.
Nearby, Petra Gomez, a mother of five, had filled her cart with dog food and cleaning supplies, including the lilac-scented Fabulosa liquid cleaner. "I have had to put off my wants like sandals and shirts, because money is tight and the kids come first," Ms. Gomez said.
Family Dollar Chief Executive Howard Levine told analysts during the conference call that the company's recent efforts to look for the best deals from suppliers around the globe and stock more higher-margin private-label foods and other items will help offset some of the company's rising costs, including its stepped-up remodeling program.
But analysts cautioned that a second consecutive disappointing quarter at Family Dollar, whose growth and operational improvements like remodelings lag behind Dollar General's, could renew speculation about a leveraged buyout of the chain.
In February, Family Dollar rejected a takeover offer from activist investor Nelson Peltz, head of Trian Fund. Since then, activist investor William Ackman of Pershing Square Capital, has amassed just under 10% of the company's stock, making him the largest shareholder.
"We're executing our strategic plan, and hopefully we'll finish our fiscal year in August strong," said a Family Dollar spokesman.
Dollar Tree is the top performer among the three dollar chains, with the highest same-store sales gains and slimmest margin-rate decline.
Dollar Tree sells a lower percentage of food than its rivals and doesn't offer clothing. But it does a brisk business in products like party goods and seasonal decorations, all for just $1. Half its new customers have family incomes of more than $70,000.
"I think of Dollar Tree as a Target trade-down," said Ms. Shapira.